Tournament Like Fields With Asymetric and Convex Payouts Favor High-Variance Strategies

Fields that exhibit tournaments with asymmetric and convex payouts favor high-variance strategies (variance from the benchmark mean).

For example, fund managers that end up on the Morningstar list (top fund managers) tend to be founder-managed funds with highly concentrated positions (they also underperform in later periods). High variance from an index benchmark is favorable because if you make it to the top fund manager list you will receive many more clients and make a lot on fields.

Another example is baseball where, before Babe Ruth, the prevailing strategy was high-contact (hitting many singles). Babe Ruth showed a high-variance strategy by swinging for the fences every time. His failure rate was much higher (he led the league in strikeouts), but he also overwhelmingly led the league in home runs making him one of the most valuable players in the league. (A corollary in recent times is the rise of three pointers in basketball).

Other fields that exhibit this incentive for high-variance strategies include politics (making outrageous statements until something stick has little downside these days) and venture capital (losses are capped, but gains are not).

Read Swinging for the Fences.

See also:

  • Advantages Accrue to the Leader

    Markets exhibit the Pareto principle in that most of the advantages accrue to a small number of players—mostly number one. These advantages include growing faster, network effects, recruiting the best people, expanding to new opportunities quickly and most of the 7 Powers.

  • Governments Are Comfortable Thinking Long Term When it Comes to Infrastructure

    While government tends to be short-term oriented (the election cycle drives decisions so officials can be re-elected), an area the do feel comfortable thinking long term is infrastructure. With regularity, they will initiate projects to build roads, telecommunications, buildings, and other infrastructure that takes many years to build (the second avenue subway line in Manhattan started in 1972).

  • The Economics of Superstars

    There are two common elements of economic superstars. First, there is a close connection between personal reward and size of the market. Second, there is a tendency for market size and reward to be skewed to the most talented people in the field.

  • Psychology Overwhelms Fundamentals in the Short Run

    In discussing market changes, Howard Marks, remarks that psychology overwhelms fundamentals in the short run as the reason why markets can appear irrational. This is a neat way of holding both the idea that investors are rational and markets are irrational simultaneously.